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“MANAGEMENT” FEES IN THE POST BEPS WORLD: A TOWER OF BABEL?

The Organisation for Economic Co-operation and Development (OECD) in 2017 reissued its Transfer Pricing Guidelines as part of its Base Erosion and Profit Shifting (BEPS) work. As part of this reissuance, it substantially expanded and elaborated its discussion and recommendations pertaining to intra-group services fees (“IGSF”). This expansion and elaboration, from our experience to date, is that such intragroup services fees are being subject to more rigorous scrutiny by taxing authorities. We provide herein some of the key changes of the OECD’s transfer pricing services guidelines, and provide insights as to what multinational enterprises (MNE) should do to ensure a solid validation of their IGSF from a transfer pricing perspective.

The OECD in Chapter VII, paragraph 7.2 notes that, “Nearly every MNE group must arrange for a wide scope of services to be available to its members, in particular administrative, technical, financial and commercial services. Such services may include management, coordination and control functions for the whole group…” This is an important statement in that it explicitly recognizes the value of corporate oversight and influence on its international subsidiaries. The OECD then defines the two criteria which are critical for a MNE to validate in order for its intercompany charges to be accepted by a local tax authority: (1) whether the intragroup service has indeed been rendered to an affiliate, and (2) what is the appropriate charge for that service.

This is an interesting approach as it seems that the OECD is trying have it both the ways. It recognizes the vertical and horizontal integration of the MNE and how that integration benefits members of the group, but then challenges the MNE to prove the benefit as being worthy of being received by the members and charged by the MNE.

Following are seven suggestions on how to validate intragroup service fees provided by the MNE’s headquarters (or in some cases its regional affiliate). We refer to the service provided as the Base Entity. We hope these are a reasonable start to ensure your IGSF is well established and validated:

Characterize the fees properly: Too often, Base Entities will aggregate all services into a single charge called “management fees”. While the OECD recognizes that there are management and control type of services provided by a MNE to its affiliates, our experience with this blanket terminology is that it creates confusion with local tax authorities. If the local affiliate has a local manager, then there is no need for an external “management” fee. Further, the term management implies control, which in some jurisdictions could infer that the Base Entity itself is doing business in the local jurisdiction apart from the business that its affiliate is engaged in, and that its own business profits could be subject to a tax examination;

Create an employee chart list of the Base Entity personnel: Both an employee list chart of the Base Entity and a similar chart of the local employees will help to highlight in many instances the services being provided by the Base Entity. This chart should be designed in a way to accentuate that the Base Entity personnel roles are not duplicative. Proof of lack of duplicativeness could include facts such as years of experience, or number of visits per year made to a local affiliate, if relevant. Many such characteristics exist to highlight the Base Entity’s essence;

Business Descriptions of Services: This point is obvious. The OECD Guidelines on intragroup services requires a description of each service provided by the Base Entity, as well as how this service benefits the local affiliate. Its value should be highlighted. Any transfer pricing assessment on IGSF must have this element;

Do not rely on an aggregation of intercompany transactions economic analysis to validate your IGSF: We have seen many transfer pricing studies where there are multiple intercompany transactions, with but one of them being IGFS charges. In many of these studies, the transfer pricing analyst aggregates all the intercompany transactions together and performs an overall bottom line profit assessment (i.e., a Comparable Profits Method or Transactional Net Margin Method operating profit return). This type of assessment on its own is almost a guarantee of a tax examination. While we do not recommend eliminating the overall profit assessment, we note that a distinct assessment ought to be made pertaining to the IGSF charges themselves with #3 above;

Ensure you are including all costs in the allocation: This article is too short to provide an extensive review of the OECD’s expanded service fee principles. Note: the types of expenses that once fell into the category of fees that cannot be allocated (i.e., stewardship expenses) have been materially reduced;

Carefully assess the methodology relied on to charge your service fees: The OECD Guidelines note negatively that “…in respect of financial services such as loans, foreign exchange and hedging, all of the remuneration may be built into the spread and it would not be appropriate to expect a further service fee to be charged if such were the case. Similarly, in some buying or procurement services a commission element may be incorporated in the price of the product or services procured, and a separate service fee may not be appropriate.” Note that the opposite is also true. If certain services are not built into a transaction, they ought to be separately charged, and potentially not based on a cost-based allocation method.

Ensure you have a distinct intercompany services fee agreement: A specific agreement for IGFS is essential and is always one of the first items requested in a tax examination. Further, coordination between the services described in the agreement and those documented in the transfer pricing analysis is essential. Revisions to the types of services provided obligates the intercompany agreement to be amended.

The OECD’s Transfer Pricing Guidelines are much more expansive and detailed. A MNE’s failure to coordinate its IGSF with these guidelines and to explicitly adhere to specifics detailed in the guidelines, including items that are not discussed above such as means of allocating the expenses, the benefits test, and documenting whether one’s charge is according to a direct method or indirect method, will potentially create a tax examination chaos, i.e., a Tower of Babel. Explaining after the fact is always more difficult than explaining contemporaneously.

The transfer pricing specialists at Moore Doeren Mayhew can help you with the OECD’s Transfer Pricing Guidelines. Do not hesitate to contact us.

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